There are two great fiscal legacies of American liberalism since Franklin Roosevelt. One is the invention and broad public acceptance of social insurance—notably Social Security, unemployment compensation, and Medicare. The other is the use of public spending, both to increase human and physical productivity over the long term and for macroeconomic stimulus during recessions. There are of course other activist uses of modern government—to regulate economic inefficiency and to advance social justice—but social insurance and social investment are the two fiscal pillars of modern liberalism.
Unfortunately, the Clinton administration, seconded by far too many nominally liberal economists, is needlessly sacrificing the latter to salvage the former. In order to "save Social Security," such conservative conceits as permanent surpluses and the discrediting of public and social investment are suddenly conventional wisdom at the White House. Some of this is merely tactical; some of it is intended to win the confidence of Wall Street. But the embrace of permanent surpluses at the expense of other public outlays is dangerous overkill.
Some recent history: After equivocating for months, the administration at last decided to resist the calls for partial privatization of Social Security. Instead, the President, in his State of the Union address, proposed to put fully 62 percent of the projected 15-year budget surplus into Social Security reserves. The President further stole the right's clothes by proposing that a small amount of the Social Security funds—about 10 percent—be put into the stock market, collectively and not through individual accounts. Yet another slice of the surplus is to underwrite a new system of private nest eggs, but as a supplement to and not a partial replacement for Social Security. This part of the Clinton plan is just dandy.
As short-run partisan tactics, the White House contrived a very clever "two-fer." First, the plan nearly sidetracked the calls to turn Social Security into private investment accounts. Second, the President used public support for Social Security and Medicare to trump Republican calls for a general tax cut. Under the Clinton proposal, another 15 percent of the projected long-term surplus would go to Medicare. So, more than three-quarters of the budget surplus would be dedicated to social insurance. All of this exquisitely stymied the Republican right. Some Republicans, notably Budget Chairman John Kasich and Ways and Means Chairman Bill Archer, continued to promote the GOP's 10 percent across-the- board tax cut. Others, such as the new speaker Dennis Hastert, almost immediately backed off and proposed narrower, targeted tax cuts for such favorites as capital gains.
A general tax cut has two big problems. First, it is expensive—about a trillion dollars over ten years. It would be very hard to enact one and also carry out the Clinton program for saving Social Security and Medicare. Second, most of the proposed tax cut would go to the well-off. Because working people tend to pay more of their total tax burden via payroll taxes, the average taxpayer would get a rebate of just $99 and some 48 million households at the bottom would get no tax relief at all. The top 1 percent, meanwhile, with average incomes of over $800,000, would get tax cuts averaging more than $20,000 each. The original GOP proposal beautifully defines the Republicans as the party prepared to sacrifice Social Security and Medicare for the sake of a tax cut for the rich. A "targeted" tax cut for capital gains is even more heavily tilted to the rich. This, of course, is all wonderful grist for Democrats.
So far, so good. But the administration and its economist allies are so enamored of the strategy of using surpluses to stifle tax cuts that they are also using them to shackle necessary public spending. The surplus has become such a tactical security blanket for the administration that the White House and its allies are propounding an odd new doctrine—the gospel of permanent surplus.
In February and March, the administration worked closely with several liberal economists to draft a letter essentially defending its plan for the surplus, not as a rescuer of Social Security but as a boon to savings rates. The letter plainly appeals to economic shibboleths beloved on Wall Street and among conservative academics: public spending crowds out investment; private investment is productive, public investment is not.
The letter said, in part:
President Clinton has made the correct decision in his budget proposal, namely to save most of the $4.4 trillion of the net budget surpluses projected by the administration over the next 15 years. Instead of using this money for tax cuts or unproductive spending, the government will use the bulk of it to buy back government debt, reducing debt in the hands of the public from 44 percent of GDP today to about 7 percent in 2014, according to administration estimates. This will free up trillions in the hands of private investors who will be able to lend the money to businesses for investment in new plant and equipment. Saving and investing now is the only real way to prepare for the retirement of the baby boomers. Saving now will increase the ability of the economy to produce food, shelter and clothing in the future.
This letter, inspired and coordinated by the administration, is a blend of dubious economics and bad politics. Stripped of the tactical opposition to a Republican tax cut, it reads like an editorial from Forbes. Consider first the economic fallacies.
The most glaring is the notion that public spending is by definition unproductive while private savings and investment engender growth. The entire first tier of moderately liberal economists signed the letter, including several nominal Keynesians who have written for this magazine. Ironically, several of the group, most notably Alicia Munnell, have long been associated with the view that public investment needs to be increased, precisely in order to promote productivity growth. Others, such as Nobelists James Tobin and Robert Solow, have long been defenders of countercyclical public spending for economic stimulus. Prior to this letter, virtually nobody among the signers was an advocate of the idea that the national debt should be paid down to zero.
On the contrary, several of these leading economists were making the opposite arguments in pro–public investment economists' letters published in 1995 and 1989. In 1995—when the political context was resisting a balanced budget amendment—the letter was headed "America Needs Public Investment Now and for the Future." The letter contended, "Just as business must continuously invest in order to prosper, so must a nation. Higher productivity—the key to higher living standards—is a function of public, as well as private, investment." Among the 435 signatories were Nobelists Kenneth Arrow, James Tobin, and Lawrence Klein, who also signed the 1999 letter making the opposite argument.
The 1989 economists' letter referred to a "third deficit": besides the widely decried budget and trade deficits, there was a severe deficit of public investment in physical infrastructure and human capital. The signatories then included Henry Aaron, Robert Solow, Peter Diamond, Alan Blinder, and Paul Krugman—as well as several others who signed the anti–public spending 1999 letter. The 1989 letter, in dramatic contrast to the current one, noted that "without adequate training and an efficient economic infrastructure, tomorrow's workers will not be able to maintain tomorrow's retirees in a comfortable and dignified standard of living." Quite so.
The 1999 economists' letter also embraces the concept of "crowding out"—the idea that public borrowing competes for capital with the private sector and raises the costs of private investment. However, true crowding out is only a problem when the economy is at full capacity and full employment, and it is far less of an issue in a global economy. America's current savings rates are among the world's lowest, yet American business has no trouble getting cheap capital because investors worldwide have great respect for the dynamism of our economy.
Why the change of heart? If anything, the case for fiscal prudence was stronger in years past. In 1989 and 1995, unlike today, the budget had a large deficit. It also had higher levels of social spending than today. But in 1989 a Republican president was in power; and in 1995 Republican legislators were on the verge of enacting a constitutional amendment requiring budget balance. So the recent letter should be understood as merely partisan posturing. Yet distinguished economists should know better than to adopt short-run tactical postures that many apparently don't entirely believe.
It's probably true that over the long run the United States should cultivate higher savings rates. Rich countries should be net exporters of capital to developing economies, not magnets for flight capital. However there are many ways to increase the U.S. savings rate, including promoting private pension plans (which are now being cut back by industry) and favoring household savings for a variety of purposes such as education, training, and first-time home ownership. The economists who circulated and signed this letter are evidently so obsessed with the savings rate issue that they are relying exclusively on "government saving"—budget surpluses—on the theory that a higher national savings rate is the magic bullet for higher economic growth.
The trouble with that theory is that growth has picked up smartly in the past few years, and savings rates have nothing to do with it; saving is currently near a postwar low. Rather, the long-promised boom in information technology is at last producing real gains in productivity, which in turn allow higher rates of non-inflationary growth and fuller non-inflationary employment. And the Federal Reserve Board is cooperating with low interest rates. As long as there is a global capital market, the domestic savings rate is just not a major part of this equation. It's certainly true that the key to financing the retirement of the baby-boom generation will be higher growth rates in the next century. But there is more to high growth than government savings. And here is the real mischief of surplus worship.
As candidate Bill Clinton explained so eloquently in 1992 in "Putting People First," America needs more public investment in order to have a more productive private economy. Since the early 1960s, general government outlays relative to GDP have actually been halved, and are projected to be cut even further. As research and development spending by the defense establishment has been cut, private R&D outlays have not made up the gap. In the 1980s, liberals were writing pamphlets with titles like "America in Ruins," documenting the declining investment in physical infrastructure. There is an estimated shortfall of $112 billion just in the physical rehabilitation of classrooms. Physical infrastructure overlaps with social investment, especially in the key area of human capital. Both parties are competing with each other to stand for excellence in education, yet the politics of surplus worship precludes anything more than token increases in spending for education and training, which is actually falling in real terms relative to GDP.
The economists' letter is correct in one respect. The prosperity of the next century will indeed depend on the productivity and growth of the economy. Put another way, today's five-year-olds need to grow up to be sufficiently productive members of the workforce to support their grandparents. But as these same economists apparently understood four years ago and ten years ago, that depends in part on how well they are educated and trained; on whether somebody is caring for them as children while both their parents are under financial pressure to hold paid jobs; on whether they are healthy; on whether the economy has decent systems of roads and bridges and airports; and on whether public outlays for research hold up.
One can look at surplus worship in two other ways. One view holds that social insurance has in effect crowded out other public spending. There is certainly an element of truth to that; on the other hand, as the population ages, it makes a certain amount of sense to pay for decent health care for older Americans and to keep them out of poverty by adequately financing Social Security. But this argument begs the question of why we need perennial surpluses at all.
Looked at in long-term perspective, the idea that high growth requires that the national debt be paid down to effectively zero is ludicrous. It was Treasury Secretary Alexander Hamilton who argued that the young nation needed a national debt both as a source of public investment and as an instrument of banking policy. (One wonders: How will the Federal Reserve conduct monetary policy when there are no more Treasury securities? What would that do to the stability of the bond market?) In the nineteenth century, public debt financed the opening of the West. In this century, deficits and public debt got us part way out of the Great Depression, and debt on a scale never before imagined enabled us to build a scientific and military machine that won World War II.
The U.S. came out of the war with a debt equal to 120 percent of one year's GDP—more than double the debt ratio at the peak of the Reagan-Bush deficit binges. Yet there was no obsession in the late 1940s to "pay down debt." On the contrary, the government ran an annual deficit through the postwar boom years that averaged about 1.2 percent of GDP. Yet the rate of debt to GDP declined dramatically nonetheless. Why? It declined for the same reason that it has declined since 1996—because the economy grew at a faster rate than the debt.
By the early 1970s, the debt had declined all the way to about 24 percent of one year's GDP, even though the economy normally ran a moderate deficit. And such deficits can be defended, both for stimulus during recessions and to finance social investment during normal times. It is nothing short of disgraceful that a Democratic administration and nominally Democratic economists should embrace paying down public debt as an end in itself. The U.S. already has a lower ratio of debt to GDP than most industrial nations.
Instead of becoming worshipers of endless budget surpluses and embracing the idea that public outlays crowd out private, we need to revive the case for public investment. Budget balance, much less permanent surplus, is simply the wrong fiscal criterion. The right criterion is a deficit that allows the debt to remain stable, or decline slightly, relative to GDP. For example, if we think it would be prudent to get the debt back down to its postwar low of around 24 percent of GDP, we could run deficits—call them capital budgets—of 1 percent of GDP for the next decade. One percent of GDP, by the way, is around $100 billion a year. That's enough money to finance a lot of compensatory education, a lot of training, a lot of expansion of airports and high-speed rail lines. Just 20 percent of that amount could finance comprehensive drug coverage for Medicare recipients.
Just a decade ago, the U.S. Conference of Mayors, then under the leadership of Boston Mayor Ray Flynn, devised the idea of a standby list of deferred public investments; in a recession, the federal government would release special funds and the projects would be fast-tracked. A version of the idea made it into candidate Bill Clinton's economic stimulus package. Since that era, the "third deficit" of which liberals spoke has, of course, gotten worse.
General federal spending—exclusive of social insurance, defense, and interest on the debt—is now at its lowest level relative to GDP in 40 years. In 1998, it was just 3.4 percent of GDP, compared to about 5 percent in the Carter years and over 4 percent in Lyndon Johnson's Great Society. And general government spending—for education, training, child care, housing, public health, and infrastructure—will head even lower, to 2.9 percent by 2004 under the Clinton budget, thanks to pressure for permanent surplus. You have to be a true laissez-faire ideologue to believe this is good for economic growth. It is a measure of how far we've fallen that hardly anyone talks about the need for expanded social outlays anymore. The mark of a realist is to talk of budget surpluses.
Some Washington cynics make the following argument: Don't worry about this stuff. It's just rhetoric. It's just short-term tactics. The Social Security deal may not pass anyway, because Republicans will insist on some form of private account "carve-out" as their price of support. We just need to do this budget-surplus gambit to defeat the Republican tax cut. And anyway, nobody knows the real 15-year budget picture, much less the 75-year Social Security picture. Politics lives and dies in the short term. So let's just get through this year, stave off the tax cut, and if the Democrats take back Congress we can talk about spending again. I have heard key policymakers offer these arguments almost in these exact words.
But this view is too clever by half. For one thing, President Clinton may not be able to resist the temptation to make a deal—give the Republicans just a little slice, just an entering wedge, of Social Security. And where does that leave the Democrats who have pledged to stand by the Clinton plan? Is the plan the one he announced in the State of the Union address, or whatever plan he devises in the end game? Democrats have been led down this path before, on welfare reform, on NAFTA, and on the last budget deal.
Second, all this talk about permanent surpluses and savings rates and unproductive spending does real damage to the content of public debate. It leaves Democrats validating the most conservative Republican premises about how the economy works. It places the issue of social outlays outside the national conversation entirely. It makes government the bad guy.
So we need to hold the President to nothing short of his original Social Security plan, with no further compromises. And we need to rehabilitate the value of public spending—and even of public borrowing. As someone said, we need to put people first.